I am a research fellow at the Hoover Institution, at Stanford, and the Cullen Professor of Economics at the University of Houston. I am also a research professor at the German Institute for Economic Research Berlin. My specialties are Russia and Comparative Economics, and I am adding China to my portfolio. I have written more than 20 books on economics, Russia and comparative economics. I blog at paulgregorysblog.blogspot.com.

Too Big To Fail Banks Crumble Before Greedy Federal Government In Mortgage Deal

The $8.5 billion mortgage settlement agreed to by ten major banks on January 7 reveals, once more, the coercive power of government to expropriate assets from businesses judged guilty by public opinion without proof of legal wrongdoing. Eligible home owners will receive from hundreds of dollars up to $125,000 — another case where the government “throws a little money at everyone and hopes the problem will go away.” (New York TimesThe Foreclosure Disaster).

Following a familiar pattern, ten accused mortgage lenders caved to demands of the Office of the Controller of Currency (OCC) and the Federal Reserve rather than face the wrath of the regulators who rule over them. In violation of basic legal principles, settlement funds are to be distributed in small portions to all who had the potential to be harmed, not in proportion to actual damages. Such an arrangement is akin to distributing Hurricane Sandy Funds to all residents of the affected states on the grounds that they could potentially have been harmed, whether they were or not.

Profits before people! The left screams. They must be made to pay what they owe.

Among the latest of leftist legends: Big Banks lure naïve families into buying unaffordable homes under false pretenses to rake in obscene profits when they repossess them. The Leftist narrative paints a lurid picture of “a take-no-prisoners financial system” that “deceives and pushes around — and possibly throws (home owners) out onto the street” but does not explain how a lender can profit from unpaid loans.

A corollary to the left’s narrative: Big banks caused this mess; hence, they should pay for it. Anyone who argues differently, such as the Wall Street Journal, is just as guilty as the banks they defend. No proof is necessary. We all know mortgage banks engage in “massive fraud” and must “atone for their mortgage sins,” just as Toyota had to pay for the non-existent electrical flaws in its cars.

Such claptrap is the bedrock of countless Hollywood movies in which an intrepid whistleblower dodges black helicopters, robotic-like thugs in black suits, and spraying bullets to triumph over corporate evil.

This leftist vision lies deeply embedded in the public consciousness. Few stop to consider that corporate officers bear a legal fiduciary responsibility to shareholders to guard and build the corporations in which they have invested. Illegal or reckless behavior threatens company profits, corporate jobs, and the very existence of corporations. BP’s Gulf oil spill cost some thirty billion dollars in value within a few days and its CEO his job. False reporting of profits caused Enron and WorldCom stockholders to lose their entire investments and sent corporate officers to jail. The German manufacturer of Thalidomide continues to be vilified a half century after its birth defect disaster of the early 1960s.

The Left would rather you not know a basic fact of mortgage lending: The very last thing mortgage companies want is a messy foreclosure that sticks them with distressed properties which they must dispose of at a substantial loss. Foreclosures impair balance sheets as banks write down their loan assets; they are legally and administratively costly, and are public relations disasters. Mortgage companies normally work with home owners to keep them in their homes with foreclosure only as a last resort.

The housing crisis that hit with a vengeance in 2008 gave Washington its chance to unleash its regulatory power on mortgage lenders in a manner that would make Tony Soprano proud. Federal bank regulators strangled bank operations with requirements to hire outside experts to review each and every one of the four million loans in some stage of foreclosure in 2009 and 2010. The mortgage lenders were charged with technical errors, such as failing to properly review foreclosure documents. With the expert reviews proceeding at a snail’s pace, the banks had already paid more than one billion in fees and faced billions more.

The Feds extracted the $8.5 billion with no evidence of systematic wrongdoing. The settlement stopped the time-consuming case-by-case reviews of loan documents, which had yet to reveal any systematic wrongdoing. As one of the government’s Spinmeisters admitted: “The extent of the wrongdoing, if any, during the foreclosures will never be known… We are not looking for actual errors or harm.” Instead, “all 3.8 million borrowers will be slotted into categories of errors (such as misapplied fees or denials of loan modifications) that could have occurred.”

Consider what the government Spinmeister just said: Mortgage bankers may have imposed damage on customers in the process of foreclosure. We do not know if they did and on whom the damage was inflicted. Nevertheless we can strong arm them into a settlement in which anyone and everyone they could have harmed will receive a settlement, whether they were harmed or not.

Following standard procedure, the ten banks welcomed the settlement with smiling faces, knowing failure to settle could have cost them much more in terms of regulatory repression.

Did this mortgage settlement make anything better?

Well, it allowed the federal government to announce that it had brought evil mortgage bankers to justice in “the largest cash payout to date.” The liberal press could claim that, in agreeing to the settlement, the offending Wall Street bankers had admitted guilt. (They had not, but who pays attention to details?)

Overlooked by this hoopla is the economic damage the federal government imposed on society and the economy in its handling of mortgages and the housing crisis.

In any bubble-bust scenario, recovery cannot begin until prices reach their bottom. Any delay will hold back the general recovery. Housing prices suffered their largest one year decline in 2008. They did not record a one year rise until 2012. Today, they are twenty percent lower than when President Obama was inaugurated. The painfully slow recovery of the housing sector helps explain the slowest recovery in postwar history.

Government pressure to keep people in houses they cannot afford during housing busts keeps these homes off the market and slows the adjustment process. In states with expedited reviews of foreclosures, the housing recovery began earlier. The “good intentions” of the Obama administrations had the unintended consequence of delaying the recovery. Those dependent on work in residential construction can thank the liberal policies of Washington for their missing paychecks.

Washington’s pressure on mortgage lenders to modify mortgages, reduce principal, or look the other way when payments are delayed harmed the recovery in a more fundamental way. Why would lenders make mortgage loans when they can be forced, at any time, by mafia-like threats regulators to change the terms of the loan to their disadvantage?

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Here you are: In 2010, three banking regulators conducted reviews at 14 loan servicers, and examined 2,800 foreclosure files for homeowners who were in foreclosure between 2009 and 2010.

The regulators found: “The reviews found critical weaknesses in servicers’ foreclosure governance processes, foreclosure document preparation processes, and oversight and monitoring of third-party vendors, including foreclosure attorneys. While it is important to note that findings varied across institutions, the weaknesses at each servicer, individually or collectively, resulted in unsafe and unsound practices and violations of applicable federal and state law and requirements.”

The study you cite comes to quite negative conclusions concerning government intervention in mortgage renegotiations;

The main rationale for policy intervention in debt renegotiation is to enhance such activity when foreclosures are perceived to be inefficiently high. We examine the ability of the government to influence debt renegotiation by empirically evaluating the effects of the 2009 Home Affordable Modification Program that provided intermediaries (servicers) with sizeable financial incentives to renegotiate mortgages….Our findings reveal that the ability of government to quickly induce changes in behavior of large intermediaries through financial incentives is quite limited, underscoring significant barriers to the effectiveness of such polices.

Outstanding article! I only wish the self-proclaimed “liberals” would bother to get another point of view and simply read this. Yes, the root of all evil is the Federal government with its draconian approach to “remedying” an ailing economy it broke in the first place by perpetuating more of the same self-destructive economic policy. In all fairness, the “conservatives” in office of late are just as guilty of recklessly spending phony, fiat money. That said, I have no sympathy for our Federal Reserve Banks or their subsidiary banks. These banks are happy to collude with our spend-crazy Federal government to “inject liquidity” (see, print, loan, and saturate our ever-weakening dollar with trillions of phony dollars) into the economy in the first place. This ongoing policy of “liquidity injections” is what actually creates boom-bust cycles and causes the continuous instability in which we all now live. The answer is to abolish the Federal Reserve Banks and remove the Federal government’s source of all this phony, free money. By default, this would prevent the federal government from perpetuating its reckless spending sprees (on wars to nowhere and extravagant entitlement programs that encourage the unmotivated and disenfranchised to simply stay put and keep on getting those free unemployment checks, food stamps, free phones, free medical care, free education, etc.).

Excellent article explaining what really happened — the government prolonged and exacerbated the process of clearing out the problem mortgages by delaying foreclosures and introducing various modification programs which didn’t have much success.

To cover the failure of the HARP and HAMP and other programs, they pandered to claims of mortgage company bad faith, and went on this silly search for proof that banks/mortgage companies misled borrowers so that they could foreclose on as many people as possible (thus driving up bank losses!) Banks already try to keep people paying and in their homes…foreclosure is horribly expensive for the banks. NO WONDER these foreclosure reviews did not find systematic wrongful foreclosing … it makes no sense.

Problem is/was that most of the people the government wanted to help couldn’t afford the homes…not even with a modification, and many of the borrowers had commited fraud to get these “bad mortgages” by overstating income, being a straw borrower, or falsifying intent to occupy so they could buy rental property, or do a quick flip.

Excellent observations. While one can always find some example of greed or malice in human affairs the overpowering impression of mortgage lenders I have from my own experience is: incompetence. I can’t help thinking the far better course would have been to let the badly impaired outfits go broke during the 2008 panic instead of bailing them out. Doing so had the potential to be a rather ugly affair but it would have purged the rottenness from the system. And it would have sent a loud clear message to the financial businesses: screw up and you lose. Instead we’re stuck with a three ring circus of banks staggering along, unable to lend aggressively, suffering the death of a thousand cuts from regulators trying to entertain a gullible public with tales of greed and malice.

another Forbes “spin job”. Thanks for that, Paul. When banks collude to raise the rate the mortgages are tied to (LIBOR) to force borrowers into default, that should be allowed? Banks take homes in fraudulent foreclosure actions with false affidavits and forged assignments and bank law firms commit racketeering, wire fraud, forgery, and abuse of process, and that should be allowed? judges rule against borrowers to protect their own retirement plans that hold billions in bank stocks and MBS, and somehow borrowers are demanding too much? Should banks NOT be held to legal parameters just because they’re banks? The crew at FORBES continues to disparage borrowers and protect banksters in the name of, what? Capitalism? Fair trade? It’s fraud, plain and simple. The contract was void at the beginning when the lender identity was not disclosed. Fraud is at the heart of all these deals. Stop protecting the criminals.

This contributor is obviously wearing blinders. Or is so socially challenged that he has no idea what faces the common person in the US as a result of the Banking/Mortgage bubble burst. I and my family have been struggling with greater than a 50% loss in value of our home and property. Unable to refinance because of the Banking industries profiteering and subsequent false escalation of values prior to the collapse. No bank will touch a refinance, since the Loan to Value is now so underwater. Cant use Harp 2.0 its not a fannie or freddie loan. and in our area a jobless rate in excess of 11% Great credit, no late payments, and quite frankly everything done that could be done. The result will be the same. We may lose our home. Now where is the justice we seek. and who is responsible. If this contributor thinks that the banks will do anything to help those they finessed, think again. It wont happen. You can spout all the rhetoric you want but when it comes down to it it’s everyman for himself. So in my opinion they made their bed.